It's both endearing and infuriating to watch American corporate executives wring their hands about how the injustices of the U.S. tax code are forcing them — forcing them! — to reincorporate overseas through the procedure known as inversion.

Endearing, because one wants to sympathize with the pain felt by a homegrown CEO having to move a homegrown American company's headquarters to Ireland, Switzerland or some other foreign clime, just to remain competitive.

Infuriating, because they're so full of it. ...

Defenders of inversions say they don't really affect the American company's U.S. taxes — that's the claim made recently in the Wall Street Journal by Miles White, chairman of Abbott Laboratories, which is conniving with Mylan on its inversion deal.

But like much that's said about inversions, that's misleading, says Edward D. Kleinbard, a USC law professor whose role as a former chief of staff to the Congressional Joint Committee on Taxation certifies him as one of our leading experts on the corporate tax.

The claim that the corporate tax makes U.S. companies uncompetitive, he says, is "a complete red herring." Inversions aren't about improving competitiveness, Kleinbard observes. They're about making use of the huge cash hoards American companies have accumulated overseas. Kleinbard estimates this "stateless income" at roughly $1 trillion. It can't be spent directly in the United States without incurring a steep tax, and it's too large a sum to be profitably deployed outside the U.S.

Inversions allow companies to use these stockpiles in the U.S., at much lower cost.

Inversions also allow companies to use their overseas money as intracorporate loans to their domestic operations, charging the loan cost to their U.S. subsidiaries. This effectively pares down their U.S. domestic tax base, Kleinbard explains, which reduces their domestic taxes. Technically, the company's U.S. tax rate doesn't change, as White says. But it's applied to a smaller amount of declared income. ...

Kleinbard proposes a three-pronged approach. First is to close a loophole allowing an American firm to declare itself foreign-owned if at least 20% of its post-merger shareholders are foreign. The threshold should be 50%, which would require inversions to be genuine foreign acquisitions. This would put the kibosh on many, if not most, pending deals. This change has been proposed by the Obama administration and introduced in Congress by Rep. Sander M. Levin (D-Mich.).

Kleinbard also advocates tightening up rules against earnings-stripping, largely by lowering the limit on how heavily a company can saddle its U.S. operations with debt. Finally, he suggests ending "hopscotch" maneuvers, through which an inverted company bypasses U.S. tax rules by advancing its offshore cash stockpile directly to the new foreign company.

The appeal to corporate morality is eye-catching enough. But rhetoric like this has limited effectiveness. The proper way to deal with corporate immorality is to wipe it out through the law. "There is a breach of moral obligation and fiduciary duty here," Kleinbard says. "The moral failing is the refusal of Congress to do the most fundamental kind of loophole-closing."

In other words, the most effective comeback to "it's legal" is this: "It was legal. But not anymore."

Comments

It would help if some of these reporters knew anything about tax before writing.
1. An inversion would not reduce tax on US sourced income (income earned within the US.)
2. The US tax rate is effectively 40% when you include state income tax. Only Canada, Japan and Switzerland have state equivalents and their rates are usually blended into the total tax reported.
3. There already are two interest stripping limitations on the books – IRC sections 163(j) and 267.
4. How can the author say what the effective rate of tax is in various countries? I have seen that asserted but it is hard to imagine how it is calculated since much of the data would be private.
When a US company repatriates funds it pays approximately 40%. When, say, Nestle brings home the bacon, it pays in the low 20s. So the average foreign multinational keeps 1/3rd more after tax cash than a US multi. I know math is hard but let’s say the foreign multi has 40% US profits and 60% rest of the world. This would produce after-tax cash of $71 vs. $60 for the US (assuming they bring all the profit home)– or the foreigner keeps an extra 18% of every dollar of profit to invest, expand or pay to shareholders. Doesn’t this seem like being non-US is a big advantage?